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It is a little odd. The UK enters its worst downturn ever recorded; average wages increase at a rate that is much slower than inflation meaning that for some time average households have been getting worse off, but what do house prices do? Sure they crashed in the US; they crashed across much of Europe – especially in the troubled parts of the region – they crashed in the UK once too, but that was back in the 1990s.

But this time around, prices fell – a bit – but right now, and without doubt, they appear to be on an upwards trajectory. Some say there are similarities between the UK economy over the last few years and Japan 20 years ago. There is one glaring difference, however. In Japan house prices crashed and went on crashing. In the UK, the story has been quite different. So why is that? And can we expect a happy ending for the UK housing market?

Now Vince Cable has joined the ranks of those who fear that the government may be creating a housing bubble. He was interviewed on the ‘Andrew Marr Show’ yesterday, and said: “I am worried of the danger of getting into another housing bubble.” But frankly the warnings have been coming from every quarter and indeed from every quintile or even decagonal.
There is more than one side to this debate. What the UK needs is more construction, and more new houses.

One figure being bandied about at the moment is that every pound spent on construction stimulates the economy by £3. A residential construction boom needs mortgages to be made available. The danger is that mortgage supply will rise, demand for housing will increase but supply won’t. If that were to happen we might get higher house prices, but it is questionable whether UK plc will be better off.

In fairness to the chancellor he is trying. When he recently unveiled his latest initiative for his Help to Buy Scheme, he invited house builders along to hear his announcement first hand. And there are signs of a pick-up in construction. After falling to its lowest level since 2001 in the first quarter of this year UK construction activity rose 0.9 per cent in Q2, according to the ONS.
A rough rule of thumb might go like this: a buoyant mortgage market leading to more construction is good, but one leading to higher prices but not more construction is bad.

Yet the UK media seem obsessed with the idea that rising house prices is a good thing. If we get the slightest hint that house prices are set to rise, certain newspapers splash it all over their front cover. In recent days we have seen the media say over and again: the weather is hot, Britain is winning in sport and house prices are going up!

But why is it really seen as a good thing when house prices rise? Why are the UK public so convinced house prices can only ever rise? One argument to justify the argument that house prices can only ever rise in the UK is that the UK is an island and land is in limited supply. If that is so, how is it that house prices have fallen in Japan, which you may have noticed is also an island based economy?

Ex MPC man – a man famous for his ultra-dove-like view on monetary policy, a man who continuously voted for more QE, and indeed called for QE being used far more imaginatively – Adam Posen penned a piece for the ‘FT’ this weekend and he made a good case. In an article headlined “The cult of home ownership is dangerous and damaging”, Mr Posen said: “There is no iron law that higher-income economies must have higher rates of home ownership: Mexico,

Nepal and Russia all have home-ownership rates of more than 80 per cent, while the French, German and Japanese rates are 30-40 percentage points lower. The US and the UK rates sit between them at about 65 to 70 per cent.”

Mr Posen’s main point is that because in the UK our home is our main financial asset, he said: “We incentivise middle-class households to leverage the bulk of their savings into a highly volatile, difficult to price asset.”

There is one point about the housing market which gets overlooked. Sure housing has proven to be good investment over the last few decades, but the reason for this is not because house prices keep going up, it is because housing investment is just about the only form of investment available to the mass market that employs leverage.

You borrow 75 per cent of the value of a property, and the property doubles in value, your equity increases fivefold. Leverage is also available to private equity companies, which is why they enjoyed a boom during the noughties, but leverage of investment trusts was one of the factors behind the stock market boom that led to the 1929 crash. Leverage is appealing but it is also dangerous.

But here is a theory – just a theory – as to why the Brits so love the idea of house prices as an investment.

The Brits have bought into a story. It was a story that had its roots in the 1960s and 1970s. At the beginning of this period, house prices to income were quite cheap. Over the following two decades four things happened. Firstly, as mortgages became more widely available, house prices to income rose. Secondly, as productivity grew, real wages rose. Thirdly, inflation meant nominal incomes rose very sharply. Fourthly, for much of this period, real interest rates were negative, that is to say the percentage rate of interest was less than the percentage rate of inflation. These four factors, when combined with the magic of leverage, made buying a house an incredibly lucrative thing to do.

During this period the idea was born that when you enter the housing market the best thing to do was buy the most expensive property you could. This period also saw the birth of a new metaphor, ‘the housing ladder’. The story that emerged during this period is so strong that people still think its lesson applies today.

But is that right? House prices are no longer cheap relative to incomes. Real incomes have not been rising for some time. Nominal wages have been rising only very slowly. Sure, real interest rates are negative again. But what will happen when the baby boomers retire, and many of them try to downsize, using the spare equity in their homes? What will happen if real interest rates rise, because of actions beyond the control of the Bank of England? See: The Great Reset

The narrative of the UK housing market suggests that house prices always go up. But many of the facts that created that narrative have changed.

When pieces of the narrative are changed at a later date, the overall initial impression is unaltered. The narrative changes us, and retrospective changes to the narrative don’t reverse the original effect it had on us. If we were to find out years after we first heard the story that that actually Cinderella, was a manipulative little so and so, we would probably still think she had an evil step mother and sisters.

Until that is the narrative is proven to be wrong beyond any doubt. But by then, it may be too late to do anything about it.

This morning the latest stats on the UK’s economic performance for the second quarter of this year were out. And on this occasion the ONS revealed a pretty good set of numbers. This is what they say.

In Q2 the UK economy expanded by 0.6 per cent, after growing 0.3 per cent in Q1. Year on year growth is now 1.4 per cent. Okay, growth of 1.4 per cent is way below what the UK needs, and what it used to enjoy, but it is the best performance for some time, and that needs to be celebrated.

Okay, the UK economy’s total output is still some 3.3 per cent below the 2008 peak, so the downturn, or if want to use more emotive words the depression, still continues. It seems likely that the UK will see total output continue to be less than the 2008 peak until either very late next year or in 2015, making this easily the longest downturn ever recorded.

Some point to debt levels in the UK, and say we are kidding ourselves. The truth is that if you take total UK debt – that’s government, household, corporate, and financial – the UK is one of the more indebted countries in the world. Of the world’s largest developed countries, only Japan has more total debt. Indeed financial debt is still running at some 202 per cent of GDP, which is easily the highest level amongst the world largest developed economies.

Household debt remains too high, and furthermore is expected to rise over the next couple of years. If, because of global forces outside the control of the Bank of England, interest rates rise, households and so-called zombie companies will face a major challenge. For a very bearish view on UK debt, see: The next crisis, by Ann Pettifor For what might happen to UK households if rates rise, see: What will happen to households as rates rise For the danger posed by Zombie companies, see: The Zombies are back And for why rates may rise regardless of what the Bank of England wants, see: The Great Reset

George Osborne seems to have decreed that house prices will never fall; not on his watch. This may well earn his political party election victory, but is it what the UK needs?

The UK doesn’t need a house prices boom, but it does need a housing construction boom. And in this respect there is good news. According to the Royal Institution of Chartered Surveyors (RICS), over the coming twelve months 59 per cent more surveyors who responded to its latest construction survey said that they predict workloads will continue to rise rather than fall. RICS said: “With every pound spent on construction in the UK generating almost three pounds of wider economic growth, this will undoubtedly be seen as good news for UK plc.”

And now return to today’s ONS report. In Q2 there was an upward contribution (0.08 percentage points) from production; with manufacturing increasing by 0.4 per cent following negative growth of 0.2 per cent in Q1 2013. So that is not hot air; that is real. In Q2 2013, output in the construction industry was estimated to have increased by 0.9 per cent compared with Q1 2013. In Q1 2013, construction output was at its lowest level since Q1 2001.

There is still much that can go wrong, and George Osborne is playing with fire with his help to buy scheme, but that does not mean to say that this time around the entire recovery is built on an illusion. This time it feels more real.

In the UK there is something confusing going on. They call it the productivity puzzle. Why is it that during the worst downturn ever suffered by the UK – at least it’s the worst since the beginning of the last century which is how far back the data goes – employment has kept growing to the extent that this year it passed an all-time high? Data provides a hard answer: productivity has been falling. But what the data does not do is provide the reason why.

Maybe the reason can be provided by the existence of Zombie companies. Once again, hard data comes to our aid – they really do appear to exist.

So interest rates were slashed to record lows, and then just to be sure they were slashed some more. That was the story of the great downturn: record low rates. If things had been different, if central banks have been more circumspect, had fretted about inflation, and moral hazard, then the great recession of 2008/09, and the downturn that began in 2008 would have been far far worse.

Company liquidations and indeed individual insolvency levels would have soared. House prices might have crashed. Unemployment would have risen to horrendous levels, and youth unemployment would have topped 50 per cent in some regions. In fact if the Bank of England and the Fed had adopted that policy, the UK and the US would have ended up looking a lot like the Eurozone.

Fortunately, in the democratic countries of the UK and the US the electorate would have never have tolerated such a state of affairs. It appears that the electorate in certain Eurozone countries was powerless to act; their cross on the electoral ballot had as much meaning as an Egyptian voting for the Muslim Brotherhood.

But just because record low rates stopped the UK from suffering an even worse downturn, it does not mean that the policy hasn’t come with disadvantages.

A year or so ago, the then FSA issued data showing that between 5 and 8 per cent of mortgages could be subject to forbearance. At that time, Dr Angus Armstrong at the National Institute of Economic and Social Research said: “This has a familiar ring of the zombie firms in Japan which were insolvent but the banks would not close to avoid crystallising a loss.”

But what about the corporate world? We keep hearing about zombie companies, but are they for real?

So here is the data:

First off here is the chart that shows something is wrong:

And now here is the chart that shows why zombie companies may provide a partial explanation.

The Bank of England put it this way: “Liquidations have risen only modestly since the financial crisis, even though data from companies’ accounts suggest that the proportion of companies making a loss is higher than in the early 1990s. Insolvency professionals suggest that more businesses have been able to survive the 2008/09 recession because of the low level of Bank Rate, coupled with increased forbearance. That includes forbearance by banks on existing loans, by HMRC on outstanding tax payments, and by other companies on late payments.

Forbearance and low interest rates will allow some viable businesses to remain in operation through a temporary period of weak demand. But in other cases, where businesses will find it hard to compete in their markets when demand recovers, forbearance acts as an impediment to the efficient reallocation of capital and labour, reducing underlying productivity growth. Similarly, it may have dampened the incentives to carry out the restructuring needed by some companies in order to grow strongly.”

But in the US, where the central bank has been just as proactive as the Bank of England in promoting low interest rates, things have been different.

As far as households are concerned, there is a key difference in the way in which the mortgage market operates. In the UK if you find yourself with negative equity, having your home repossessed does not help because it is still your responsibility to pay the shortfall. In the US, it is the bank’s responsibility. This has led to a more ruthless approach to mortgage repossessions in the US, but at least this is kinder on those with negative equity and who cannot meet commitments, and it is has led to fewer so-called zombie households.

As for companies and entrepreneurs, in the US the same stigma does not apply to bankruptcy as there is in the UK. Indeed for US entrepreneurs, it sometimes feels as if facing bankruptcy is a sort of rite of passage. Chapter 11 is often applied very effectively in the US – consider GM for example.

In the US, we have seen record low interest rates, but creative destruction too.

In the UK where –to a large extent – we have only had record low rates, it may become a problem as the economy recovers, and rates finally rise.

House prices might be rising in the UK, but that is not what’s happening across most of Europe.

According to new data from the EU Commission, house prices across the Eurozone fell 2.2 per cent year on year in the first quarter of this year. Across the EU they fell 1.4 per cent.

Among the Member States for which data are available, the highest annual increases in house prices in the first quarter of 2013 were recorded in Estonia (+7.7 per cent), Latvia (+7.2 per cent), Luxembourg (+4.3 per cent), and Sweden (+4.1 per cent), and the largest falls were seen in Spain (-12.8 per cent), Hungary (-9.3 per cent), Portugal (-7.3 per cent), and the Netherlands (-7.2 per cent).

In France they were down 1.4 per cent. They fell 5.7 per cent in Italy, 3.0 per cent in Ireland, and 0.4 per cent in Cyprus.

The latest data for Germany is not yet available, but in Q2 2012 they rose 2.3 per cent, year on year.

According to recent OECD data, when comparing average house prices to rent, they are 71 per cent above the historic average in Norway, 64 per cent more than average in Canada, 63 per cent more in Belgium, 61 per cent in New Zealand, 38 per cent in Finland, 37 per cent in Australia, 35 per cent in France, 32 per cent in Sweden, and 31 per cent in the UK.

Prices to rent are below the historic average in the US, Japan, Germany, Italy, Czech Republic, Greece, Ireland, Iceland, Portugal, Slovak Republic, Slovenia and Switzerland. In the case of Japan, Germany, Greece, Ireland, Portugal and Slovenia they are less than 80 per cent of the average relative to rents.

During the height of the euro crisis, politicians in Europe, and indeed central bankers, blamed the markets and credit ratings agencies. Yesterday an official at the Fed followed that tactic too.

Richard Fisher, president of the Dallas Federal Reserve, told the ‘FT’: “I do believe that big money does organize itself somewhat like feral hogs. If they detect a weakness or a bad scent, they go after it.”

He also took the opportunity of being interviewed by the ‘FT’ to remind us all about George Soros – the man who shorted sterling in 1992, beat the Bank of England and hastened the UK’s departure from the ERM. He likened today’s feral hogs to Mr Soros, but is that right?

Being a messenger is never a good place to be, not if you bring bad news anyway. When Eurozone politicians blamed credit ratings agencies, and what they called bond vigilantes for the woes in Europe, they were surely deluding themselves. They had fooled themselves into thinking the crisis was less serious than it was, and they thought they could talk until the cows came home. The markets went some way towards correcting their complacency.

By hastening the UK’s departure from the ERM, George Soros probably did the UK a favour.

But what about this time?

Markets are selling because there are fears that interest rates are set to rise. The Fed has said as much, and even in China there are signs of monetary tightening.

But don’t forget that the news out of the US has been good of late. To remind you of two of the highlights: US banks’ profits were at an all-time high in Q1, and US households have cut debt substantially since 2007.

As things stand, the Dow remains substantially up on its start of year position as does the Nikkei 225 in Japan. And that makes sense.

Markets probably overdid their exuberance in May, but both the US and Japan are in a better place now than they were at the beginning of the year.

As far as equities are concerned, in addition to fears about the Fed tightening monetary policy, some are nervous about the possibility that US profits to GDP are set to fall. But in the long run, profits to GDP falling and wages to GDP rising is surely good thing.
Even higher interest rates are a good thing, if higher rates are symptomatic of the economy returning to normal.

But higher interest rates will be bad news for those with high debts, and for that reason the UK and – more so – the Eurozone may lose out.

The FTSE 100 has not performed as well as US markets this year. Unlike the Dow, it never did pass its all-time high. And unlike the Dow, the FTSE 100 has now fallen to within a whisker of its start of year price. That is probably about right.

But at least the UK has its own central bank, free to print money and buy bonds via quantitative easing.

The countries of the indebted Eurozone do not have such a luxury, which is why Europe may yet be the biggest loser.

The IMF is a critic. It reckons the US has hit the brakes too fast, and wants to see more stimulus measures. As for the UK, it wants to see more short term borrowing to fund investment into infrastructure. The Bank of International Settlements (BIS), often called the world’s central bank, is a critic too, but for almost the opposite reasons.

Time to stop doing whatever it takes.

In a report out today, the BIS began by referring to Mario Draghi’s famous words when he said: “We will do whatever it takes to save the euro.” The BIS said: “But we are past the height of the crisis, and the goal of policy today is to return to strong and sustainable growth. Authorities need to hasten structural reforms so that economic resources can more easily be used in the most productive manner. Households and firms have to complete the repair of their balance sheets.

Governments must redouble their efforts to ensure the sustainability of their finances. And regulators have to adapt the rules to an increasingly interconnected and complex financial system and ensure that banks set aside sufficient capital to match the associated risks. Only forceful efforts at such repair and reform can return economies to strong and sustainable real growth.”

This is pure austerity economics, right out of the Austrian school of economics.

Then the BIS laid into what are often called the zombies.

It said: “Productivity gains and employment in the major advanced economies have sagged in recent years, especially where pre-crisis growth was severely unbalanced. Before they can return to sustainable growth, these countries will need to reallocate labour and capital across sectors. Structural rigidities that hamper this process are likely to hold back the economy’s productive potential. Both productivity and employment tend to be weaker in economies with rigid product markets than in ones with more flexible ones.

Similarly, employment rates tend to be lower where labour markets are more rigid.Conversely, countries with flexible labour markets recover more quickly from severely imbalanced downturns. They also create more jobs. Reforms that enhance the flexibility of labour and product markets could be swiftly rewarded with improved growth and employment.”

So what is it really saying?

Firstly, that QE has run its course, and monetary policy needs to return to normal. Secondly, that we need to see more creative destruction; let businesses fail, because the vacuum that is created can be filled by more efficient firms, and productivity will start to improve.

But is that really right? The BIS might be saying that QE has done its job, and now it is time to go back to normal, but frankly it never was a fan of QE in the first place. It may say that now is the time for governments to pay back debts, but then it also said that last year and the year before.

It is suggesting that as the economy changes, now is the time to implement the changes that it wanted to see implemented even before the economy had changed.

Do we really need to see create destruction? Take one sector, as an example, the UK High Street. This has seen rather a lot of destruction to date, precious little creativity has followed.

Then again, the recovery does appear to be starting in the US, and say one thing for the US, it does have an extraordinary ability to reinvent itself.

Being a cynic is fun. It is a good laugh, finding the flaws in any hint of optimism. And many have had a ball of a time laughing at the argument that it is good news on the US economy that lies behind the Fed announcing plans to ease back on QE.

But actually, there really has been good news coming out of the US of late. And with signs that US manufacturing is finding new opportunities, even that 3D printing may create new jobs, we could even be at the early stages of seeing something of a reversal of what we have seen in recent years of the trend of growing inequality.

The BIS might be right to say we are approaching the time when the US needs to see monetary policy return to normal – but that is happening anyway.

But the euro needs is own version of QE, proper QE that is, not Draghi playing with words. Japan’s experiment in Abeonomics needs to be given more time, and QE needs to be used more imaginatively to directly fund investment in the UK.

History tells us, that monetary policy has often been reversed too soon while an economy recovered from a depression recession/depression. Right now, there is a real danger that monetary policy will be tightened too soon. And the BIS seems to be oblivious to this risk.

Sometimes data is too good to ignore, and the latest Economics Review from the ONS contains such data. It shows that the star of the recession of 2008 was Canada. In Q1 of this year, Canadian GDP was no less than 5.1 per cent up on the pre-recession high.

US GDP was 3.2 per cent up, German GDP 1.3 per cent up, but French GDP is still 0.8 per cent below the pre-recession peak. In Japan GDP is now 1.3 per cent below peak, and for poor old Blighty, GDP is still 2.6 per cent below peak. Within the G7, Italy has suffered the worst performance, with GDP currently 8.6 per cent below peak.

Japan saw the steepest rate of decline during the recession, however, and at one point GDP was 9.2 per cent below peak before its recovery began.

So far, all is good for Canada. Just bear this mind, however. Levels of household debt in Canada seem high; they have risen since 2007, and are now even higher than in the UK and much higher than in the US. Meanwhile, Canadian house prices to both income and rent, relative to their historic average, seem excessive.

There are parallels between Canada today, and the US and the UK in 2007.